Navigating Fed Neutral Policy and the Risk of Recurring Supply Shocks

This week, Federal Reserve Chair Jerome Powell warned that the U.S. may be entering a period of more frequent and persistent supply shocks—a difficult challenge for both markets and policymakers. It’s a notable shift in tone and a cue for advisors to keep both inflation risk and economic growth outlooks in view.

Market Overview

Markets were mixed last week:

• S&P 500: -0.45%

• NASDAQ Composite: -0.26%

• Russell 2000: +0.14%

Among sectors, Industrials (+1.1%), Consumer Discretionary (+0.8%), and Utilities (+0.6%) posted gains, while Health Care (-4.2%), Communication Services (-2.4%), and Real Estate (-0.8%) lagged.

In fixed income, Treasury yields edged higher, with the 10-year yield rising to 4.37%. High yield bond spreads narrowed by 7 bps to 353bps, reflecting cautious optimism around policy stability.

Earnings & Economic Data

Despite trade-related concerns and rate policy in flux, Q1 earnings season came in strong: 90% of S&P 500 companies have reported, with EPS growth now at 13.4% (FactSet). If trade policy moderates, this strength could support ongoing recovery in equity markets.

The Fed held its benchmark rate steady at 4.25%–4.50%, reiterating a data-dependent stance. Powell emphasized balance—acknowledging risks from both inflation and unemployment—and pointed to “neutral” policy levels for now.

The economy and inflation model aids in forecasting the near-term direction of the components of the economy that are most highly correlated with asset class returns.

How Fed Neutrality and Supply Shocks Are Shaping Portfolio Strategy

The evolving balance between Fed neutral policy and supply shocks is shaping the macroeconomic outlook more than any single data point. The Fed’s neutral stance masks a deeper tension. Powell’s recent remarks about supply shocks suggest the path ahead could be more volatile than recent cycles. While the Fed has historically been aggressive in fighting downturns, it now faces the challenge of acting without overstimulating.

Trade policy remains a wildcard. If tariffs re-escalate or the consumer pulls back, the Fed may eventually be forced to respond. But the threshold appears higher than in past cycles—especially with stagflation risks lingering.

Our View: Focus on What Can Be Controlled

While monetary policy remains neutral and earnings are holding up, the message is clear: uncertainty is back. For advisors, this is a time to stay disciplined:

• Diversification still matters. Tariff risks and policy delays may hit sectors unevenly.

• Fixed income positioning is key. TIPS and short-duration bonds remain effective hedges.

• Monitor spreads. High yield spreads have improved, but implied volatility suggests caution.

ARP Update: Risk On

Quartz’s Adaptive Risk Premium (ARP) score sits at +0.44, maintaining a “Risk On” environment. While near-term risk remains elevated, the underlying macro regime continues to support measured risk exposure.

ARP Score: +0.44  Market Risk Status: Risk On  Shiller PE: 36.36

Chart in Focus

High yield bond spreads surged to 461bps in early April after U.S. tariff announcements. They’ve since narrowed to 320bps, reflecting stronger sentiment and earnings resilience. A move below 300bps may be difficult without policy relief or a decline in volatility.

High yield bond spreads reacted strongly to US trade policy news, spiking to a high of 461bps on April 7. Since then, spreads have tracked stock market optimism surrounding positive trade developments and currently sit at 320bps. A return below 300bps will be difficult given the lingering impact of tariffs and rising implied volatility. 

Looking Ahead

• FOMC Speeches (5/19)

• G7 Meetings (5/20–5/22)

• Canada CPI (5/20)

• Eurozone PMIs (5/22)

• U.S. New Home Sales (5/23)

We continue to monitor the balance between policy risk and market resilience. If you'd like to discuss how this evolving environment could impact your allocation strategy, let’s connect.